Can you save tax by investing a severance payment in a company? – Money sense

How is a lump sum severance payment taxed?

If you lose your job and receive severance pay, it can be paid out in a lump sum. Generally, it is a certain number of weeks of salary that increases based on factors such as seniority, age and length of service. However, other factors may play a role.

When you receive a lump sum payment, the withholding tax is usually only 30%. The problem is that regardless of the withholding tax on a lump sum severance payment or any other source of income, when you file your tax return, the correct tax rate is determined.

If you receive a large severance payment, or already have a high income, the tax on the payment can be an additional 20% or more.

Related reading: How to avoid tax on severance pay

How is continued payment of wages taxed?

If you lose your job, you can continue to receive your normal salary for a certain period of time. This is called continued payment of wages.

The payroll tax is the same as if you continued to receive wages. The result is that your tax withholding should be more or less in line with what your tax will be due on your tax return, barring other sources of income, tax deductions or tax credits.

How does a company save taxes?

Companies can help defer taxes and save, Geoffrey, but that depends on the circumstances. The best tax application for a business is to earn active business income. If you run a business and make profits through a business that you leave in the business and don’t withdraw, it may be subject to a low tax rate.

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Depending on the province or territory, this can be as high as 9 to 12%. There will be more taxes to pay if you withdraw the money and use it personally, but a corporation is definitely a great tax deferral tool.

The problem with severance pay is that it is employment income. If you have it paid out to a company or if you transfer the payment to a company, the T4 employment income does not magically convert into active business income of the company. As a result, a company will not help you save taxes on a severance package.

Does investing money in a business save taxes?

The tax rate on investment income earned in a business is comparable to the top tax rate in most provinces and territories. As a result, earning investment income in a business often results in comparable or even more tax than earning it personally, Geoffrey.

So why do people use investment holding companies? The reason is the aforementioned small business tax rate of 9 to 12%. If you earn business income and can leave it in a business to invest, you may be able to invest about 90 cents on the dollar of your business profit.

Business owners often do this through a separate investment holding company, where they can transfer funds from their active business. However, investing your personal savings into a business for investment typically doesn’t save you taxes.

How can you save tax on a layoff?

If you want to save tax on a severance package, there are two simple ways, Geoffrey.

The first is to contribute to your Registered Retirement Savings Plan (RRSP). You may even have the option to have your employer transfer some or all of your severance pay directly to your RRSP, without withholding taxes. But remember, this is like getting your tax refund in advance. You will also not receive any tax back when you file your tax return.

The second option is to postpone the severance payment to the next year. Particularly if it is later in the calendar year, your employer may be willing to defer payment until January to push the payroll tax back a year. Some employers pay severance pay over several years, but this is less common.